Solid Information and Analysis Trumps Ideology with MPSERS

Rick Olson, State Representative, 55^th District
June 20, 2012 Revised version

The Capitol Confidential article “House GOP Hides Behind Rigged 'Study'” dated June 18, 2012 http://www.michigancapitolconfidential.com/17075 is wrong.

When our House four member Work Group on MPSERS began our work months ago, we all leaned toward having all new employees in the school systems enrolled into a defined contribution plan instead of the “hybrid” plan begun with legislation in 2010. Then we learned that if we were to be consistent in providing school employees with what the state employees’ received through their defined contribution plan, the costs may actually be higher than what the state would incur with the hybrid plan.

How can this be, when the current MPSERS employer contribution rates are 25% and rising? First we need to dissect what is contained in the current contribution rates. Of the 27.37% contribution rate for fiscal year 2012-13 for employees hired before July 1, 2010, 15.86% is for the Pension Unfunded Accrued Liability, 2.66% is for the Early Retirement Incentive enacted in 2010 amortized over 5 years, 8.75% is for Retiree Health Care, and only 3.47% is the “Pension Normal Rate”. The “normal” cost is the amount needed to fund the pension benefits earned in that year according to the actuaries’ calculations. This is the rate that must be compared with the cost of a defined contribution plan.

For state employees, the state pays 4% of wages, plus matches up to 3% more if the employee voluntarily contributes into the plan, for a maximum of 7%. The actual history is the state paying about 6.2%, because all employees do not contribute the amount necessary for that state to reach the 3% maximum match. So, knowing that the hybrid plan is much less rich a benefit plan than for employees hired prior to July 1, 2012, we asked what the “normal cost” was for employees in the hybrid plan. We learned that they were 2.24% for fiscal year 2013 and 2.67% in fiscal year 2014. Hmm, these costs were lower than 6.2%. If we wished to reduce the cost of the MPSERS program to employees, did it make sense to adopt a plan that was higher cost? We opted to recommend sticking with the hybrid plan for new employees.

The Senate adopted a version of SB 1040 that would have closed out the defined benefit plan and placed all new employees into a defined contribution plan. This would have the effect under Government Accounting Standards Board guidelines of requiring a quicker amortization of the unfunded liability than if we stuck with the existing plan. This would make it difficult to do both the pre-funding of the health care benefits that the House favored and funding the amount that the GASB rules indicated needed to be reported as the “annual required contribution” (“ARC”).

We in the House recognized that we did not have all of the information we needed to make a fully informed decision to close the defined benefit program and adopt the defined contribution plan the Senate preferred.

a) That is, the lower normal cost of the hybrid plan is a calculated percentage, based on certain assumptions, including a 7% investment rate of return. We want to see some sensitivity analysis of what the cost would be if the actual rate of return were 6%, 5%, 4%, etc. While we will not be able to predict exactly what the future investment return will be, we would know how sensitive the calculated cost of the hybrid plan is to different investment rates.
Any defined benefit plan, including the hybrid plan, contains the risk that the assumptions used by the actuaries in calculating the “normal cost” are overly optimistic. If the cost of the hybrid plan assuming a 6% investment rate of return is greater than the 6.2% cost likely under a defined contribution plan, we might well decide that adopting the defined contribution plan makes sense. If such a small variance from the actuaries’ assumptions makes such large difference in actual cost, the risk is high that the hybrid plan might end up more expensive than the defined contribution plan that does not rely on assumptions. It might make sense to eliminate that risk altogether and adopt the defined contribution plan. On the other hand, if the cost of the hybrid plan is still cheaper with a 2% investment rate of return, sticking with the hybrid plan would most likely be less costly in the long run.

b) Further, the proponents of the defined contribution program claimed that the state was not required to actually fund the program according to the amounts calculated and reported in the financial statements as required by GASB. We don’t know how the bond rating agencies would react to the state failing to fund the ARC. The study is intended to allow time for our bonding professionals to contact the key bonding agencies and attempt to determine what their reaction might be if that were to occur.

With the results of the study this fall, it may turn out that the risk is low that the defined benefit plan will be more costly and that the bonding agencies will not adversely rate our state’s bonds if we were to close out the defined benefit plan but not fully fund the ARC. If so, then it may make sense to take this step, in addition to the pre-funding of the health care benefits as planned in the H-3 substitute Senate Bill 1040 as passed by the House of Representatives.

If not, we will have made significant progress to bringing the costs of the MPSERS program under control, capped the contribution rate employers would pay, reduced the unfunded liability an estimated $15.6 billion, taken a stride toward taking care of the “stranded cost” problem, and all while being reasonable with our valued public school employees and retirees.

This is a case where solid information and analysis trumped the ideological arguments made by the Mackinac Center when the House approved its version of SB 1040.